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Week Ahead: Interest rates, Mexican stand-off and US CPI

After last week’s noticeable falls, global stock markets have rallied even more sharply this week to more than wipe out those losses. Sentiment has been boosted by major central banks moving towards easing while trade tensions have taken a back seat. There may well be some further follow through in risk appetite early next week, although it is worth keeping an eye on the US-Mexico situation as tensions could flare up again if the two sides fail to reach an agreement ahead of Monday’s planned tariff hikes.

Doves galore

This week alone, we have seen Australia’s central bank reduce interest rates for the first time in three years on Tuesday, India delivered its third cut of 2019 on Thursday, while several Fed officials, including Chairman Jerome Powell, provided hints that monetary policy in the US may be loosened as well this year, after the odds of a cut surged. However, the European Central Bank was not as dovish as some had expected, causing the euro to strength on Thursday. Even so, the fact that the ECB has pushed back expectations of a hike to at least after H1 2020 is a dovish move.

Bad news is good news is back

With investors pricing in rate cuts from the Fed and other major central banks, yields have collapsed. The falling yields have helped to support higher-yielding stock markets. Given then fact stock markets rallied on the back of a poor US non-farm payrolls report and wages data, it looks like “bad news is good news (for stocks)” is back. Meanwhile noninterest-bearing precious metals have also been supported, this time helped also by a depreciating US dollar, which fell further on Friday in reaction to NFP.

Looking ahead to next week

It is likely that sentiment will again be dominated by rate cut expectations next week. Economists at a number investment banks have already revised their rate expectations lower, with Barclays, for example, seeing a 50 basis point cut in July! While we think that might be a little too dramatic, we also fully expect a couple of rate cuts from the Fed this year.

As investors price in lower interest rates and for longer, the stock market rally may continue for a while yet, even if trade concerns are lurking in the background. However, in the event the US chooses not to delay the imposition of tariffs on Mexico, which has been planned for Monday, then the indices may ease back early next week in knee-jerk reaction. Mexico says some progress has been made to stem the flow of migrants into the States, but it is not clear whether an agreement could be reached in time with the White House press secretary Sarah Sanders saying “our position is still the same and we’re moving forward with the tariffs,” even if the meetings “have gone well”.

US-China trade wars could flare up again end of June

Of course, the bigger concern is China, but for now there is no fresh news on this front. US President Donald Trump has said he will decide whether to enact tariffs on another $325 billion worth of Chinese imports after the G20 meetings in Japan at the end of the month. So, there is plenty of time for the markets to focus on interest rates and on Mexico next week.

Next week’s economic data highlights

  • Depending on the US-Mexico tariffs situation, it could be an interesting open on Sunday night/Monday morning for Asian investors, especially as we will also have China’s latest trade figures to look forward to then. But it should be a quite one for European investors as banks in Germany, France and Switzerland will be closed in observance of Whit Monday. UK GDP, manufacturing production and construction output should keep pound traders busy, though. And there will be more UK data on Tuesday when the latest reading on Average Earnings Index is expected to point to a moderation in wages.
  • For the dollar, Wednesday is likely to be the next important day as we will have the latest US consumer inflation data then. Given soft wages, analysts expect a modest 0.1% month-over-month rise in CPI after a 0.3% increase in April. Surely if CPI were to come in even weaker then that could seriously dent the dollar’s bullish trend as those calling for rate cuts would only grow in confidence, giving them more reason to sell the buck.
  • Thursday’s Asian session will be dominated by Australian employment data and therefore the Aussie dollar. The focus is then likely to turn to interest rates again given the Swiss National Bank’s upcoming policy decision when Europe gets underway. So far, the SNB has (only) used negative interest rates and intervention in the currency markets to help stem the inflow of capital and cook inflation in Switzerland. However, it might be too early to use the “nuclear option” of introducing an ECB-style QE programme. The franc has recently strengthened amid safe-haven flows, and the USD/CHF fell further this week as the dollar sold off, although the CHF did weaken against the EUR as equities staged a sharp rally this week.
  • China will be in focus again Friday with the release of industrial production data from the world’s second largest economy. US retail sales will be among the data highlights during the North American session.

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